The faster retailers ran during the first half of 2008, the more inflation kept them pretty much in place, according to industry analysts, who said it may take a year or more before inflation subsides sufficiently for real sales and earnings growth to resume.
With inflation in food and, for some operators, fuel having a relentless impact on financial results, real sales growth was generally flat, and real earnings gains were absent during the first half as retailers passed through price increases and consumers traded down, the analysts pointed out.
On the surface, financial results for the top 10 chains with publicly held equity or debt looked pretty good for the first half of 2008:
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Sales increased an average of 3.7% — virtually identical to the 3.6% gain in the first half of 2007.
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Same-store sales rose an average of 3% in the first quarter, compared with 4.1% a year earlier; and 1.7% in the second quarter, compared with 2.7% in the year-ago period.
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Operating cash flow, or adjusted EBITDA (earnings before interest, depreciation and amortization), increased an average of 3.7% — down from the average gain of 5.7% in the first half of the prior year.
However, with food inflation running at 4.9% through the first half of 2008, compared with 3.3% a year earlier, and fuel inflation averaging 28%, compared with just 3% in the early part of 2007, real growth was more modest than the raw numbers would indicate, Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., told SN.
“Sales in the first six months were pretty flat, increasing an average of just 0.4% on a real basis for the entire industry, compared with real increases of 1.9% in the first half of 2007,” he pointed out.
On a comparable-store sales basis, any results below the 4.9% rate of inflation were actually negative, Wolf added, “meaning that, other than Kroger [whose first-quarter comps were 5.8% and whose second-quarter comps came in just below inflation at 4.7%], everyone's comps were actually negative.”
The increase in operating cash flow numbers was a result “of operators doing a good job of passing through inflation in product costs to maintain overall earnings,” Wolf explained.
The generally flat results in real-growth terms were related directly to the weak economy, he noted. “People had less disposable income, which impacted demand and led to lower volumes and to trading down within the stores; at the same time, some shoppers were switching from supermarkets to more discount-oriented operators.”
A year ago, analysts said supermarkets were benefiting in part from the switch by consumers from restaurants to supermarkets, but this year the supermarkets were hurt as consumers moved from supermarkets to supercenters, wholesale clubs and dollar stores, Gary Giblen, executive vice president at Goldsmith & Harris, New York, pointed out.
“That's a direct result of the weakening economy, combined with the extreme jump in gas prices,” he explained.
Chuck Cerankosky, an analyst with FTN Midwest Securities, Cleveland, said the actual financial results were reasonably strong. “Most companies showed pretty good sales growth during the first half,” he said, “since all of them were dealing with the same kind of inflationary pressures. There was clearly more inflation this year than in the first half of 2007, but I hesitate to deflate the growth numbers.
“It was clear, however, that sales were impacted as some consumers looking for both quality and value switched to other retail channels.”
Those switches accounted for part of the 1% slowdown in same-store sales growth compared with the prior year, he said, while the lower average EBITDA numbers reflected the different rates at which each company passed through cost increases, he noted.
“In addition, the chains that sell gasoline saw margins pushed down but sales grossly inflated.”
Karen Short, a New York-based analyst for Friedman, Billings, Ramsey and Co., said consumers reacted very clearly to inflated prices by trading down, “and it makes logical sense that will continue for a while, because right now there's no glimmer of hope for improvement in the economic environment.”
Carla Casella, a high-yield analyst with JP Morgan Securities, New York, told SN she believes it will be “late 2009 at best” before the situation improves, and other analysts put a similar time frame on a possible break in inflationary pressures.
Giblen said it's likely to be another 12 months at minimum before the economy eases and financial results improve. “Until then we'll remain in this mode of rapid inflation, where the health of the consumer worsens rather than improves,” he explained.
Wolf said he does not anticipate any easing of inflation till the second half of 2009. “We should see significant inflation in meat and other proteins during the first half of next year that will continue the same trends we've been seeing, and it's going to be the second half of next year at the earliest before we see enough real sales growth for the industry to start to improve its results on a real basis.”
An analysis of first-half results for each of the top 10 chains follows.
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KROGER CO., Cincinnati, whose first-half sales rose 11.7% to $41.2 billion, with same-store sales increasing 5.8% in the first quarter and 4.7% in the second, while operating cash flow rose 6.6% to $2.2 billion.
The analysts said they agree Kroger's strategies over the last few years positioned the chain perfectly to compete in the economy it faced during the first half.
Wolf said Kroger's industry-leading results were a direct result of its go-to-market strategy — a combination of price and quality propositions that had been derided by many analysts five years ago when they resulted in an earnings decline.
“It took a lot of guts for Kroger to pursue that strategy at that time, but it's put the company in a superior position to compete, particularly as we've come into a recessionary environment,” he explained.
“With everyone who was competing on convenience and quality now going after price, Kroger was already well-positioned on all counts when the economy weakened,” he said.
Giblen said Kroger's success in the half was a result “of having developed programs that brought costs and prices down. Kroger also benefited from having most of its stores in the Midwest and Texas, where farm and oil prices were strong and exposure to the housing bubble was low.”
Giblen said the chain's more modest comp-store sales gains in the second quarter (which for Kroger ended in mid-August) reflected poor back-to-school sales at its Fred Meyer division, “though Kroger's overall comps were still the best in the industry, because it's positioned right for the current economy — a result due partly to skill and partly to luck.”
According to Cerankosky, because Kroger has the most gas stations of any of the top 10 public chains, it benefited most from the inflation on its sales number and on margins. He also said Kroger has done a good job over the years “tweaking its stores to reflect local demographics.”
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SUPERVALU, Minneapolis, which saw sales rise 0.6% to $23.7 billion for the half, with flat comps at its retail stores in the fourth quarter (the first quarter of the calendar year) and negative comps of 0.9% in the first quarter, while EBITDA dropped 0.9% to $1.4 billion.
The results reflect Supervalu's focus on integrating the Albertsons store base it acquired in mid-2006 before addressing those stores' pricing programs, Giblen pointed out, “which is the right thing to do. The integration is Job No. 1 — they'll get to correcting the pricing at the former Albertsons properties later.”
Cerankosky said the wholesale side of Supervalu's business did “extremely well, which has helped offset some of the softness on the retail side — not so much in markets where the legacy stores operate as in markets where the acquired Albertsons are located, markets where competition is going after that Albertsons share more aggressively.”
While Supervalu has adjusted pricing and promotions at the acquired stores “to some extent,” Cerankosky noted, “it hasn't made any major changes yet in its go-to-market strategy at most of those stores.”
The decline in EBITDA is related to the high level of capital spending Supervalu is doing to refurbish the Albertsons stores, Cerankosky pointed out.
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SAFEWAY, Pleasanton, Calif., whose sales climbed 5.1% to $20.2 billion during the first half, while comps rose 2.9% in the first quarter and fell 0.3% in the second, and EBITDA jumped 8.8% to $1.4 billion.
“Safeway went full-bore toward a quality differentiation five years ago, without concern for price, and while that has resulted in strong earnings growth for the last few years, it's put the chain at risk of customer flight in today's down economy,” Wolf pointed out.
Adding to the challenges facing Safeway, he said, is that most of its store base is in California, “which is the hotbed of the housing crisis, and that's having a negative effect on results.”
Giblen said Safeway is comfortable with its market positioning, even if it hurts financial results in the short term. “Steve Burd [Safeway chairman, president and chief executive officer] said it makes no sense to change the chain's ‘lifestyle’ approach just because the economy lines up differently. He's willing to accept tepid sales in order to achieve a consistent message to consumers.”
The strength in Safeway's operating cash flow comes from its major effort in private label, Giblen said, and also from its Blackhawk gift card business, which is separate from the supermarkets.
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Cerankosky said Safeway's market strategy is to focus more on operating profit margin. “During the first half, Safeway experienced a deterioration in sales momentum, but operating profit margin actually improved, which meets management's strategy,” he said. “And whatever profit levels were during the first half, Safeway knows how much it will benefit from the seasonal strength of Blackhawk during the fourth quarter.”
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AHOLD USA, Quincy, Mass. — a division of Amsterdam-based Ahold — which saw first-half sales grow 3.3% to $11.7 billion, comps increase an estimated 0.4% during the first quarter and an estimated 0.7% during the second, and EBITDA decline an estimated 6.4% to $805 million.
Ahold spent most of the half trying to convince customers at its Stop & Shop stores in New England and its Giant Food stores in the Baltimore-Washington area that it was lowering prices by 10% to 15% as part of its Value Improvement Program, one analyst, who declined to be quoted by name, told SN.
That “self-imposed deflation” in pricing and margins affected earnings, he said, and comparable-store sales increases were tough to achieve because of customer skepticism that the lower-pricing offer was genuine.
“Business was up 10% at Giant of Carlisle [Pa.] during the half,” he noted, “and now that the VIP program has been completed and the message is out there, the other stores should get a sales rebound going forward.”
Giblen said Ahold's first-half results appear modest, “but they mask the fact Ahold has finally cracked the code on getting Stop & Shop and Giant of Landover [Md.] operating on a more normalized basis.”
By launching the VIP effort to lower prices at both chains and upgrading the store base through remodeling, “Ahold has improved results at both chains. Further, it has restored some of the unique programs and offerings at Giant of Landover that had been lost when it combined that operation with Stop & Shop.”
The drop in first-half EBITDA resulted from the lower-pricing program, “which takes a while before consumers perceive the change,” Giblen added.
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DELHAIZE AMERICA, Salisbury, N.C. — a division of Brussels-based Delhaize Group that operates Food Lion in the Southeast, Hannaford Bros. in New England and Sweetbay in Florida — whose first-half sales increased 3.7% to $9.3 billion, while comps rose 3.5% in the first quarter and 3.2% in the second, and EBITDA dropped 0.4% to $752 million.
“Most of Delhaize's gains were driven by inflation,” one analyst told SN.
According to Giblen, Delhaize's numbers might have looked a lot worse if they reflected results at Food Lion only. “Food Lion was getting terribly battered during the half because of the rise in gas prices, which was particularly hurtful in the Southeast, where people have to drive longer distances,” he explained.
Food Lion also lost some business to Wal-Mart Stores, “which was surprising, given the fact Food Lion is already so competitively priced,” Giblen pointed out.
Results at Hannaford in New England were better, simply because of its geography, he noted. Sweetbay in Florida, which accounts for only a small part of the company's business, did well “because its strong perishables image made it less sensitive to the economy in Florida.”
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A&P, Montvale, N.J., which acquired Pathmark Stores at the end of 2007, resulting in sales for the half of $5.1 billion, up 2%, a comps increase of 3% in the company's fourth quarter and 3.2% in the second, and EBITDA of $169.6 million, up 132%.
The relatively strong comps reflect A&P's decision 18 months ago “to get rid of its perception as a high-priced chain,” Giblen said. “Since Pathmark had lost its long-standing image as a low-priced chain, A&P was able to improve the pricing image at both banners at the same time, which enabled it to improve sales.”
That move had a negative impact on profitability, however, as A&P traded gross margin for better prices, he pointed out.
Short said the improved numbers resulted from pricing initiatives A&P launched in mid-2007, “so those programs were in place for a while before consumer perceptions caught up with them,” she pointed out, “while Pathmark benefited from more promotions, plus a boost in employee morale after years of uncertainty about whether or when it would be sold.”
According to Casella, A&P's sales got a lift resulting from store renovations at both A&P and Pathmark units. “A&P has done a better job targeting customers, based on knowledge from the Pathmark side that some stores can offer deep discounts while others can be upscale, and they're moving forward focusing stores in both banners to meet more specific demographics,” she explained.
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WHOLE FOODS MARKET, Austin, Texas, which saw sales grow 12.6% to $3.4 billion (excluding the Wild Oats Markets stores it acquired in mid-2007), as comps increased 5.1% in the chain's second quarter and 1.9% in its third, and operating cash flow dropped 0.2% to $121.9 million.
The Wild Oats stores Whole Foods operated during the half accounted for approximately 9% of sales, or approximately $350 million.
In Cerankosky's view, Whole Foods is not seeing adequate returns on the capital investments it's been making in new stores, including its venture in Great Britain. “It's gotten good returns in the past, but it's never accelerated capital spending to the degree it has now, and that's putting a lot of premium on return on sales and return on invested capital,” he said.
Giblen said most of the sales increases Whole Foods has historically been experiencing came from the large number of new stores it has been opening. But with returns slowed, the chain said earlier in the year it would slow its pace of expansion, he pointed out.
“For Whole Foods, its financial performance reflects a simple story of the meltdown of the upscale customer,” Giblen explained. “The myth that was widely believed was that the upscale, natural foods customer was invulnerable to cost. But during the half, Whole Foods realized the economy was affecting even affluent shoppers.”
While Whole Foods repositioned itself during the half with better pricing in the grocery aisles, challenges remain on the perimeter, “where most of the products it offers are top quality and therefore carry high prices,” Wolf said.
“That means demand is falling, and Whole Foods has still not cracked the code on how to position the perimeter in this kind of economy,” he said.
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WINN-DIXIE STORES, Jacksonville, Fla., whose sales for the half rose 1.6% to $3.4 billion; comps rose 2.2% in the chain's third quarter and 0.6% in its fourth; and EBITDA dropped 19.2% to $60.7 million.
Cerankosky said the first-half numbers reflect the chain's ongoing turnaround. “Winn-Dixie has a great management team in place that knows what it needs to do, which is to remodel the entire chain. And it's got to accomplish that competing with Publix.
“During the first half, Winn-Dixie was unable to meet its cash flow goals because of competitive activity, and it felt it needed to promote more, especially in the June quarter, when Publix and others were very active. Ultimately, though, it was not happy with the results.”
According to Giblen, “The whole operation was improving till it fell victim to the economic downturn across the Southeast and the housing crisis in Florida,” he said, “which affected the typical lower-income customer who shops at Winn-Dixie.”
EBITDA was seriously impacted during the chain's fourth quarter when the company got more aggressive on price promotions, he pointed out. “The company got nervous about sales, so it got more aggressive on price and frankly went overboard, and it hasn't seen any payoff yet,” Giblen said.
Short said basket size increased at Winn-Dixie by about 3.8% during the first half of the calendar year, while transactions fell 1.6% in the chain's third quarter and 3% in the fourth. “The company anticipated weak sales in the fourth quarter, but when competition heated up, it decided to boost its promotional activity, but that wasn't effective,” she explained.
“But it's clear Wall Street is concerned with Winn-Dixie's gross profit margin more so than strong top-line sales, because that allows it to maintain its cash position, and that's the area in which the chain will try to improve.”
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STATER BROS. MARKETS, San Bernardino, Calif., where sales rose 4.6% during the half to $1.9 billion, comps rose 3.7% in the chain's second quarter and 1.8% in the third, and EBITDA declined 1.2% to $100.3 million.
“As pricing became more promotional in Southern California, Stater sought to keep pace with its program of ‘aggressive EDLP,’ where it maintains everyday low prices but promotes them,” Casella said. “It also sought to do more with family sizes and bulk sales during the half to help customers cope with the weaker economy, and it generally succeeded in holding on to its base.”
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HARRIS TEETER, Matthews, N.C., a division of Ruddick Corp., Charlotte, N.C., whose supermarket sales rose 10.8% to $1.8 billion, comps rose 3.3% in the second quarter and 1.7% in the third, and EBITDA rose 16.6% to $138.4 million.
“Harris Teeter is an exceptionally strong retailer with a format that targets a higher-income demographic,” Short said, “but which, unlike Whole Foods, has price points that are only slightly higher than its competition, mainly Food Lion — though that difference is not enough to impact Harris Teeter's market share or its customer count.”
Cerankosky said Harris Teeter has benefited from opening a large number of stores each year. “They hit the gas pedal a few years ago and accelerated the number of store openings, and they've been building sales momentum ever since,” he said — citing seven openings in 2006, 12 in 2007, another 12 planned for this year and 12 more in 2009 — “and that's helping them achieve such good results.
“But as an upscale retailer, they're seeing some pressure on top-line growth, and they're reacting to changes in the consumer's market basket.”
Wolf said he agreed that most of Harris Teeter's gains are coming from new-store growth, much of which is occurring in the Washington, D.C., region, he noted.
Harris Teeter's earnings remained solid for two reasons, Wolf said — the chain's positioning in the Carolinas, where the impact of housing problems is the lowest among any other regions, and the move into the Washington area, “which is growing more profitable as the stores there mature.”
“The company anticipated weak sales in the fourth quarter, but when competition heated up, it decided to boost its promotional activity, but that wasn't effective,” she explained.
“But it's clear Wall Street is concerned with Winn-Dixie's gross profit margin more so than strong top-line sales, because that allows it to maintain its cash position, and that's the area in which the chain will try to improve.”
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STATER BROS. MARKETS, San Bernardino, Calif., where sales rose 4.6% during the half to $1.9 billion, comps rose 3.7% in the chain's second quarter and 1.8% in the third, and EBITDA declined 1.2% to $100.3 million.
“As pricing became more promotional in Southern California, Stater sought to keep pace with its program of ‘aggressive EDLP,’ where it maintains everyday low prices but promotes them,” Casella said. “It also sought to do more with family sizes and bulk sales during the half to help customers cope with the weaker economy, and it generally succeeded in holding on to its base.”
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HARRIS TEETER, Matthews, N.C., a division of Ruddick Corp., Charlotte, N.C., whose supermarket sales rose 10.8% to $1.8 billion, comps rose 3.3% in the second quarter and 1.7% in the third, and EBITDA rose 16.6% to $138.4 million.
“Harris Teeter is an exceptionally strong retailer with a format that targets a higher-income demographic,” Short said, “but which, unlike Whole Foods, has price points that are only slightly higher than its competition, mainly Food Lion — though that difference is not enough to impact Harris Teeter's market share or its customer count.”
Cerankosky said Harris Teeter has benefited from opening a large number of stores each year. “They hit the gas pedal a few years ago and accelerated the number of store openings, and they've been building sales momentum ever since,” he said — citing seven openings in 2006, 12 in 2007, another 12 planned for this year and 12 more in 2009 — “and that's helping them achieve such good results.
“But as an upscale retailer, they're seeing some pressure on top-line growth, and they're reacting to changes in the consumer's market basket.”
Wolf said he agreed that most of Harris Teeter's gains are coming from new-store growth, much of which is occurring in the Washington, D.C., region, he noted.
Harris Teeter's earnings remained solid for two reasons, Wolf said — the chain's positioning in the Carolinas, where the impact of housing problems is the lowest among any other regions, and the move into the Washington area, “which is growing more profitable as the stores there mature.”
